Brisk lending to private households flowed largely into the purchase of property. Taxsubsidized investment in owner-occupied housing has been a key driver of economic growth for a number of years and there is no evidence that the boom is slowing down. In 2003 house prices were up 17 % on a year earlier. In relation to GDP, the debt of private households has now topped the EMU average. Non-financial corporations have also failed to consolidate their finances so far. Spanish firms have not only invested more briskly than their euro area counterparts in recent years, they have also resorted more heavily to borrowing. The financial deficit stood of late at -4.8 % of GDP (Q3 2003, 12-month cumulative). In terms of their investment and staffing decisions, this hefty debt burden leaves companies vulnerable to swings in interest rates.
The private sector in Spain: Mounting consolidation pressure
In our most likely scenario - ongoing recovery with a moderate pickup in interest rates on money and capital markets - domestic demand in Spain will continue to grow, albeit at a more sedate pace. A risk scenario would be global reflation, with a sharp surge in interest rates. This would hit the private sector in Spain more severely than in most other EMU countries, clobbering consumption and investment. Falling property prices and excess capacity in the building sector would weigh on activity for years. All in all the catch-up process in Spain would stall.